Is it May Day or Mayday?

May Day.  May 1 is “celebrated in many countries as a traditional springtime festival or as an international day honoring workers.”  Mayday is “internationally recognised as an SOS distress signal.”  We have a little bit of both, as labor has become more vocal in fighting for a larger wedge of the pie in terms of wages, while financial markets are beginning to show signs of stress.

“The mayday callsign originated in 1923 by Frederick Stanley Mockford (1897–1962), a senior radio officer at Croydon Airport in London. He was asked to think of a word that would indicate distress and would easily be understood by all pilots and ground staff in an emergency.  Since much of the traffic at the time was between Croydon and Le Bourget Airport in Paris, he proposed the word ‘mayday’ from the French word ‘m’aidez’. “

http://www.nmmc.co.uk/index.php?/collections/featured_questions/why_mayday

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The SPX encountered two large tumbles in the past year, both sparked by overt central authority announcements which also corresponded with large foreign exchange moves.  In August, China devalued, and in short order SPX declined 11% from around 2100 to 1870.  In December, the Fed hiked, and by Feb 11, the SPX had declined 12%, from 2080 to 1830.  We started this week near the same level as the last two times, around 2090, going into both the FOMC and BoJ meetings.  Though both meetings resulted in inaction, the market expected easing out of the BoJ, and the Nikkei dropped 4.5% on the week with other global markets falling in sympathy.  I don’t know if this is the start of another 10+% drop in SPX, but additional announcements and factors would argue for a risk-off posture.  And of course, the old adage “Sell in May and go away” highlights the seasonal aspect of our current time frame.

In terms of the FOMC, many commentators think the Fed left the door open for a June hike.  The market assigns low probabilities to that scenario, in spite of various Fed officials suggesting the short end curve may be too complacent.  Snippets from the first sentences of the last three Fed statements indicate uneven growth in spite of improved labor market conditions.  In January, “…even as economic growth slowed late last year”.  In March, “…economic activity has been expanding at a moderate pace…” And a downgrade this week, “…economic activity appears to have slowed”.  So, if the Fed is data dependent, decelerating growth does not argue for additional hikes.  Perhaps the labor market does, but everyone knows payrolls have been solid for quite some time, with another 200k NFP expected Friday.  The Atlanta Fed’s initial GDPNow forecast (released Friday) for Q2 is 1.8%.  Recall that within a few weeks Q1 was systematically revised lower to the final of 0.6.  The NY Fed’s Nowcast for Q2 is just +0.8.  (A bit ironic since Atlanta was the supposed pessimistic one).

The BoJ was of course, more interesting in terms of market impact.  Many analysts have observed that stimulus measures from global central banks are losing their effectiveness, yet the market still clamors for more (and positions that way) leading to the dislocating moves seen at the end of last week.  Dollar/yen sank to 106.38 and stocks displayed symptoms of drug withdrawal.  From Doug Noland (link at bottom)  ”Japan’s Topix Bank Index [this week] sank 8.6%, increasing 2016 losses to 29.3%. It’s worth noting that financial stocks were under pressure globally again this week. Hong Kong’s Hang Seng Financials were down 2.8% (down 11.3% y-t-d), and European bank stocks fell 2.7% (down 16.7%)… In the US, “…the Securities Broker/Dealer index was (ominously) slammed 5.5%.”   Remember, the Herculean efforts made in 2008 were expressly instituted to save the financial architecture, and fissures are currently growing in that sector, globally.

An article last week in the Financial Times (again, noted by Doug Noland) warns that ‘China’s bond market is on edge’ and that “pledge style repos – short term, bond backed loans” have become hugely important in financing.  “A sharp worsening in market sentiment could force those borrowers into fire sales if their loans are called or cannot be rolled over.” As intimated at the start of this missive, and brought into sharper focus by the Fed itself, risks to US markets can be sparked by international events.

http://www.ft.com/intl/cms/s/0/7246cf2c-0a95-11e6-9456-444ab5211a2f.html#axzz47P4eaX5S

Starting off this week we have China’s mfg PMI, weaker than expected at 50.1.  From BBG “The manufacturing purchasing managers index stood at 50.1 last month, the nation’s statistics agency said Sunday, compared with 50.2 in March and a median estimate of 50.3 in a Bloomberg News survey of economists. The non-manufacturing PMI was at 53.5, compared with 53.8 in March”.  The Financial Times summed it up, “Pullback raises questions over impact of fiscal stimulus and lending binge”.   On Monday US ISM is expected 51.5 from 51.8.

Interestingly, the US Treasury on Friday released its FX Policy Report (link at bottom), and created a new “Monitoring List” that includes these economies: China, Japan, Korea, Taiwan and Germany.  All on double secret probation to not manipulate their currencies.  Or, as it says in the report, “…to avoid persistent exchange rate misalignments, refrain from competitive exchange rate devaluations, and not target exchange rates for competitive purposes.”  Or else.  Sort of an ‘America First’ policy.  Probably just a coincidence, but on the same day China denied access to Hong Kong’s ports by a US fleet.  “While U.S. warships frequently visit Hong Kong, port calls have been canceled at times of diplomatic strain between the two Asia-Pacific powers.”  Pure coincidence.

In any case, it appears as if the US, through both a dovish Yellen and suddenly important Jack Lew (remember him? He’s the Treasury Sec’y), want to make sure it’s the US that tilts its currency weaker, thereby strengthening oil and other commodities, giving emerging markets breathing room, and engendering inflationary impulses (fingers crossed).   As shown on the chart below, the Dollar Index is at an important support level.  And $/yen is exactly at its 38% retracement from its 2011 low of 75.35 to the high last year of 125.68.  (50% is 100.51).  My sentiment would be to cover short dollar positions on a technical basis.

 

Note however, that while commodities have rallied, the curve just doesn’t seem all that enthusiastic about the potential of inflation supported steepening.  The chart below overlays 2/10 treasury spread on the Bloomberg Commodity Index.  BCOM green and 2/10 in white.

 

 

 

 

Even the increasing prospect of President Trump pumping up infrastructure and military spending doesn’t seem to have an effect.  Yet.  As some might say, Mayday mayday mayday.

April 29. Things are different, including the Cubs

–In the not too distant past, earnings reports like FB and AMZN back to back would have caused a surge in stocks in general.  Sure, AAPL was a disappointment, but additional tailwinds should be stronger oil and commodities underpinned by a weakening dollar.  Going into the end of the week, it’s not playing out that way, with a dramatic end of the day reversal in stock index futures.
–JPY broke through 107 and now sits just above that level.  Euro area inflation was -0.2.  ZH (citing BAML) reports that bond issue cancellations are soaring in China; it seems the market is no longer welcoming fresh debt with generous terms.
–The NY Fed apparently thought the Atlanta Fed’s GDP Now estimates were a bit too pessimistic and started their own forecast, however, Atlanta was once again very close to the GDP number released yesterday at just +0.5 for Q1. I believe NY will release an estimate for Q2 today; two Friday’s ago it was 1.2%.  By the way, the NY Fed also released its staff forecast for the year, which had originally pegged 2016 at 2.5%, and has now shaved that number back to 2.0%.
–Somewhat interesting session in interest rates, as the front end outperformed the back.  Reds (year 2) were strongest on the curve closing +5.5 on the day.  Golds (year 5) were only +1.625.  The two year note yield fell 4.7 bps, while tens only eased 1.9 to 183.7.  There are a lot of conditional curve steepeners being placed in dollar options, as expectations for a June hike are squeezed out of the market and the weaker dollar is thought to contribute to a pulse in inflationary expectations.  Premium is still being offered hard.  As a friend of mine eloquently said, “there is sh-t for depth in front month futures (maybe all futures) compared to the size of the options gamma if this bitch gets going.”  And you can PRINT IT. “I don’t know how to make it any clearer to you.”  Ok…these last two lines have nothing to do with options gamma or the market, but, being baseball season, they refer to the famous Lee Elia Cubs manager press conference rant of 1983.  Quite entertaining but keep the volume low if you’re in a politically correct office.  Or, play it full blast…   https://www.youtube.com/watch?v=8S0CDtEz_Bo
–So where were we?  Right…Personal Income expected +0.3 with Spending +0.2 and Core PCE Prices +0.1.  Core yoy prices +1.7 last.  Employment Cost Index +0.6.  Chicago PMI 53.4.

–Let’s play ball

April 28. US yields fall after FOMC, and fall more after BoJ inaction

–Yields fell after the FOMC meeting, with the ten year treasury -7.5 bps to 185.6, however, the Bank of Japan’s inaction is a much larger influence on prices across the board this morning.  US yields have pushed even lower as the Nikkei fell 3.6% and $/yen traded in the low 108 handle, near new lows.  These moves are likely to cause reverberations and a possible risk-off episode across asset classes.
–The US curve flattened after the Fed, with 2/10 down 3.4 bps to just above 102.  Red/gold euro$ pack spread fell 4.625 to 73.25.  Both of these are near new lows.  In spite of crude oil’s recent rally (late yesterday to a recent new high, +1.26 to 45.30 in CLM6), the long end of the US market is loathe to price in any sort of inflation premium.  While many observers said the Fed left the door open to a hike in June, I would say that the overt reference to an economy that has slowed is a more important factor going forward.  In any case, if the curve presses to new lows, I would suspect a whole new round of forced activity will ensue.  Heightened awareness of lacking liquidity could easily see a repeat of the October 2014 treasury flash crash.  I am not predicting that, just saying the “standard deviation models” might have to be re-calibrated.
–However, if one simply looked at euro$ straddles and volatility, the conclusion would be that prices will never move again.  Let me give a few examples, last Friday ED futures prices closed very near their current levels.  For example, on Friday EDM7 9900^ was 47.0 ref 9896.5, yesterday it settled 44.0 ref 9896.  The Sept midcurve 0EU 9887.5^ went from 36.0 to 33.5.  EDM8 9875^ was 86.5 on Friday ref 9869.5, yesterday settled 84.0 ref 9870.5.  These levels appear too cheap given the global environment.  Skew in treasuries likely to shift once again toward favoring calls.
–Today’s news includes Q1 GDP expected 0.7%.  Jobless Claims expected at the still low level of 260k.  Seven year note auction.

April 27. Central Bank Carrots

–FOMC today.  There’s a chance that a hike will be clearly signaled for June, but I doubt it.  In terms of policy divergence and central bank influence, there is no end competing and seemingly random examples.  On the raw material inflation side, China stands out, as steel and iron ore have had blazing rallies due to China’s stimulus policies.  Some news articles say regulators are becoming concerned.  Exhibit one this morning is silver, up 21 cents and threatening new highs.  On the other hand, the Australian dollar tanked this morning on weak inflation data. An article on BBG about Standard Chartered has this quote from the CEO, which I suppose sums things up: ““I am expecting very high volatility for the rest of this year and probably into next year,” said Winters, 54. “It’s too early to call the risk-off theme. We could have episodes of real risk aversion.”  BoJ up next, but since last summer the Nikkei has made lower lows and lower highs.  The carrot of more etf buying is not moving the horse, it’s just moving through the horse.
–Yesterday afternoon risk aversion was on display with AAPL’s results.  Nasdaq took a tumble and is unresponsive this morning, though crude oil is at $45/bbl.  The shift in sentiment away from stocks and into commodities appears to have legs.
–A couple of large trades in interest rates yesterday.  EDM6 9912.5 puts were bought slight under 0.5 in 100k, a cover of the short leg in the 9925/9912/9900 put butterfly.  A telegraphed June hike would easily put the 9925 strike into play, but whenever Yellen steps up the plate, with the fans eager for at least a single, she whiffs.  The other trade was also an exit, the sale of 15k TYM 128 puts at 15 to 16.  Nice timing as yesterday’s earnings reports prompted a  modest move back into fixed income.

Reflation trade?

A few quick and early comments this weekend.  The first caveat, almost more of a reminder to myself than to you, is that trading off the current fundamental assessment of economic conditions can be problematic.  There are short term perceptions and positioning that can overwhelm other, longer term considerations.  (This is a much more important and painfully learned disclaimer than the pages mandated by regulators).

Yields this week rose to close at recent highs.  The ten year note yield was up 13.4 bps on the week to 188.6.  One-year Eurodollar calendar spreads also closed at the highs of the week, though they are still mostly clustered around 27 bps, so it’s still mostly perceived to be a one hike a year world.  The prevailing theme seems to be the idea of a ‘reflation’ trade, given China stimulus, and eye-popping rallies in iron ore, Shanghai rebar contract, etc.  The chart below shows rebar, iron ore, crude and the Bloomberg Commodity Index (BCOM).  BCOM is in green and indicates a more shallow rally, but it’s pretty clear that going into the week’s FOMC meeting, things are firmer than they were last time, in mid-March.

 

 

One of my themes has been that the gap between commodities and stocks would start to narrow.  That indeed is (gently) starting to be the case as shown by second chart below.  This chart is SPX/BCOM, or stocks as priced in terms of the commodity index.  Regarding reflation, the chart reflects that idea, as it’s up 2.5x from 2012 levels.  However, the reflation was in paper assets.  The chart is hugging an upward sloping trendline, though it also is potentially forming a double top.

This Wednesday’s FOMC announcement isn’t expected to bring much change.  However, a Reuters poll of 80 economists found that 2/3rds expect a hike at the June meeting.  Of those, 83.2% declined to risk any money buying the May/June FF spread for 2.5 bps which indicates odds of 20-25% of a hike at the June meeting, though Smithers sportingly wagered Jenkins a coffee and scone that the Fed would indeed hike twice this year.  OK, I made that last part up, but as has been widely circulated even in polite company, the market does not believe Smithers.  Or Rosengren for that matter.  Aug/Oct FF spread settled at 5.0, so that spread similarly prices a September Fed hike at 1 in 5.

As an aside, the issue of Brexit is a very real concern, as evidenced by Carney asking banks about contingency plans.  It will absolutely be a consideration for the Fed, as the June meeting falls right before the referendum.  And the concern factor has likely just gotten “realer” as Obama argued the US case for Britain to stay by threatening the UK with “the back of the queue.”  Good strategy.

Market participants hope for the reflation trade, and in this they are allies with the Central Banks.  The problem is that CBs want to RE-flate prices and take the sting out of over-indebtedness, by DE-flating their own currencies.  So, the BoJ is considering more negative rates (mission accomplished, the yen plunged) and the ECB said it will be expansive in its purchases of corporate bonds (from Deutsche Bank):

We think the scope of ECB corporate bond buying could potentially be much greater than we had initially anticipated in March. The ECB stands ready to buy bonds from Euro Area issuers even when their parent companies are outside of the bloc. Already we can find a number of US, UK and Swiss headquartered names that issue out of SPVs incorporated in the Euro Area. If this trend to SPV issuance catches on, then the ECB’s policies will likely be very reflationary for all credit markets across the globe, and because of a likely refinancing wave – equity markets too.

The beginning of the mission is accomplished for the ECB, as the Euro closed at April’s low.  However, these initiatives tend to complicate the Fed’s job of weakening the USD.  A large aspect of the commodity/emerging market/hi yld relief rally has been the weaker dollar, spurred on by Yellen’s dovishness in March.  This week the dollar index bounced, having tested the low of the range in effect for the past year and a quarter.

Circling back to the idea of the current economic assessment, this week we had a weak Philly Fed, with an extremely soft employment component.  The Chicago Fed National Activity Index at -0.44 was the lowest since January 2014.  The three month moving average has been negative for 8 straight months.  Friday’s Mfg PMI was weaker than expected at 50.8, vs survey of 52.  I looked for the NY Fed NowCast for growth, but since we are in the Fed’s blackout period…nothing.  However, on April 15 the nowcasts were 0.8% for Q1 and 1.2% for Q2.  Going out on a limb, my personal ‘nowcast’ is a revision lower to Q2 given the week’s data.  In which case, a forecast for 2% GDP over the year will necessitate over 3% in the second half, and the Fed’s own projection (in March) for 2016 Real GDP is 2.2%.

If the market believes the reflation trade, the curve should steepen.  German 2/10 did rally, up 9.6 bps on the week.  In the US, the 2/10 treasury spread firmed by 4.6 bps to 106.8.  Red/gold Eurodollar pack spread shown below.  It’s trying to break its long term downward sloping trendline.  But it hasn’t.  And if the Fed does happen to tilt a bit tighter in this FOMC announcement, the curve will likely flatten more.

 

Tight Fed (relative to other CBs)->stronger dollar-> weaker commodities -> pressure on EM -> flatter curve.

Loose Fed  -> weaker dollar -> pressure on ECB -> pressure on Japan -> ECB and BoJ stimulate but risk exposing impotence regarding growth -> flatter curve?

April 22. Pay Commercial Banks to Accept Funding (that oughta do it)

–BoJ meets next week, and sparked a tumble in the yen as it appears they’re considering going deeper down the negative rate rabbit hole.  Reuters –

The Bank of Japan, which meets next week, has two lending facilities. One offers banks zero-interest funding for loans to companies in high-growth industries and one provides zero-interest long-term funds to banks that increase lending more generally.

The BOJ would consider applying negative rates on both facilities, Bloomberg reported – paying commercial banks to accept funding.

–Yesterday US yields edged higher on decent volume and some notable put buying.  For example, TYM 128p were bought about 30k (open interest up 22k), settled 0’14.  FVM 119p settled 5, 15k bought as new position.  Ten year yield rose 2 to 187.   Eurodollar strip showed similar net changes, reds, greens and golds -1.875 and blues -2.375.  GOOG and MSFT reported after the close, and the market was disappointed in both, shaving 6% off GOOG.  Early news showed weakening economic conditions.  While Jobless Claims fell to multi year lows (ok, we all know that the labor market has improved), Philly Fed sank to -1.6 from an expected 9.0 and Chgo National Activity fell to -0.44, lowest since July of 2013.  Should be fairly quiet today with just PMI Mfg flash, expected 52.0.  May treasury options expire today, looking to gravitate a bit higher to the 130 strike.

–From the Wall Street Journal – “Suicides in US Climb after years of decline.”  Well sure…we’re looking at a choice between Hillary and Trump.

 

April 21. Let’s Dance…put on your red shoes and dance the blues

–Yields jumped yesterday as crude oil surged to a new high for this calendar year, with other commodities also showing strength.  The ten year yield rose 6.8 bps to 185.  Blues (4th year) were the weakest on the Eurodollar strip, closing -9.0.  Euro$ calendar spreads rose, with Dec’16/Dec’17 closing at 26.5, up 3 on the day.

–It’s been a dramatic sentiment shift since the Fed signaled an easier stance in March, and since stimulus in China kicked in.  Some of the base commodities, for example iron ore, have had monster rallies. Interest rate futures are stubbornly (yesterday anyway) pricing in a slight inflation premium.
–There’s a lot of press coverage this morning of Soros saying that China’s debt fueled economy resembles the US in 2007-8 before the implosion.  An article on Business Insider puts total debt to GDP at 249% but I have seen higher estimates.  From BBG: The broadest measure of new credit in the world’s second-biggest economy was 2.34 trillion yuan ($362 billion) last month [that’s simply a staggering amount], far exceeding the median forecast of 1.4 trillion yuan in a Bloomberg survey and signaling the government is prioritizing growth over reining in debt.
What’s happening in China “eerily resembles what happened during the financial crisis in the U.S. in 2007-08, which was similarly fueled by credit growth,” Soros said. “Most of money that banks are supplying is needed to keep bad debts and loss-making enterprises alive.”
–I can’t help thinking of Citi’s CEO Charles Prince, from July of 2007 (prescient…) “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said in an interview with the FT in Japan.
(Subject is from David Bowie’s Let’s Dance).

–There were a couple of additional items this morning noting that Chinese credit spreads are widening and swap rates are increasing.  ECB today.  In the US we have Jobless Claims expected 265k.  Philly Fed expected 9 from 12.4, and Chicago Fed Nat’l Activity…the three month moving average has been negative for 5 straight months.

April 20. Soybeans and Silver

–Here’s a headline from the FT: US Bank Revenues Fall by Most Since 2011; Wall St slump also causes profits to tumble 24%.
–In contrast the Daily Shot has a chart of lending by small commercial banks (attached) which indicates strong growth.

April 19. Rosengren: You guys got it all wrong…

–Fairly dramatic reversal in equities Monday, as the failure of an oil output agreement in Doha caused ESM to gap down 16.5 from Friday’s settlement, only to rally back 30 handles and close with a gain of +11.75.  New highs again this morning, even after NFLX and IBM traded weaker in the wake of earnings reports. The FT captured the general market sentiment with this line about MS:  “Morgan Stanley results clear very low bar.”

–Two interesting articles to note.  First, Bloomberg highlights shaky conditions in China’s $3 T corporate bond market, noting that defaults are increasing, yields are rising and new issues are being cancelled.  “Spooked by a fresh wave of defaults at state-owned enterprises, investors in China’s yuan-denominated company notes have driven up yields for nine of the past 10 days and triggered the biggest sell off in onshore junk debt since 2014. Local issuers have canceled 61.9 billion yuan ($9.6 billion) of bond sales in April alone, and Standard & Poor’s is cutting its assessment of Chinese firms at a pace unseen since 2003.”

http://www.bloomberg.com/news/articles/2016-04-18/it-s-all-suddenly-going-wrong-in-china-s-3-trillion-bond-market

It’s worth keeping in mind that China’s surprise devaluation in August was the spark that caused a hard sell off in US equities.

–Second, Boston Fed’s Rosengren thinks the markets have it wrong.  ““While I believe that gradual … rate increases are absolutely appropriate, I do not see that the risks are so elevated, nor the outlook so pessimistic, as to justify the exceptionally shallow interest rate path currently reflected in financial futures markets,” said Rosengren.

http://www.reuters.com/article/us-usa-fed-rosengren-idUSKCN0XF2V4

After Yellen warned of uncertainties and global headwinds just last month, echoed by Dudley last week, Rosengren wanders off the reservation.  So why don’t YOU step in and buy some ED calendars Eric?  Easy money, right?

–While treasuries traded lower yesterday, there was little action.  The ten year yield rose 2 bps to 177.1. May options expire Friday, and the ATM straddle (TYK 130.5) was sold down to 31/64’s and settled 30.

–On Friday there was selling of EDZ16/EDZ17 spread at 20.5.  This spread edged up to close at 22 Monday.

–Here’s an interesting point:  On Feb 11, the Dec/Dec spread closed at 16.5.  This was a panicked day with ESM closing at 1815.  By the middle of March, the spread had rebounded to 33 bps, as ESM rallied 200 points to 2017.  However, since then the spread drifted lower and in April has only ranged between 19 and 23, while ESM has tacked on another 70 points to bring the total rally to nearly 15%.  There does appear to be a disconnect between equities and the interest rate complex (Clearly Rosengren tilts toward the stock market’s view being the ‘right’ one).  Interest rate markets have taken Yellen’s warnings to heart, and have thoroughly discounted the idea of an equity inspired “wealth effect” from spurring consumption.

Tax Day

–It’s the usual stuff this Monday morning.  Two dollar swings in the price of oil on failed Doha talks, ESM falling 16 handles before fighting back, earthquakes rattling Japan and Equador, heightening concerns that CA could be next, Japanese stocks -3.4%, JPY again briefly trading below 108, Rousseff losing an impeachment vote in Brazil, Saudis threatening to dump treasuries if an inquiry ties it to 9/11, Russian aircraft buzzing US warships and planes, China landing aircraft on one of its South Sea man-made islands.  Oh, and it’s tax day.  No wonder the ten year note is up 3/32’s.
–David Rosenberg noted that Yellen used the word uncertainty ten times in her March 29 speech, and events noted above certainly underscore that idea.  Along with brexit, and China lurching back and forth between stimulus and a hard landing.  One thing that the market has become pretty certain of: no more than one Fed hike this year.  Eurodollar calendar spreads continue to compress.  EDZ16/EDH17 closed at just 4 bps on Friday!  There was an exit seller of 20k EDZ16/EDZ17 Friday at 20.5, near the low end of the range.  August/Oct FF spread (which isolates the Sept FOMC for hiking odds) closed at 3.0.  So a bit more than 10% odds of a hike in Sept.
–While it might be a risk-off world, US equities are now seen by many as a safe haven.  Central bankers routinely bring up the idea of helicopter money, assuring us that it won’t be needed, it’s simply an academic brain teaser that they think about in their free time.  Do we continue to conclude that the Central Bankers have our backs?

• ABOUT:
  Former member of the CME specializing in interest rate options and yield curve strategies.

  The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.